Be wary of ‘hard-to-understand’ products

Ten years on from the global financial crisis, investors are being warned to be cautious of buying into products which are difficult to make sense of.

Shane Oliver, the leading economist at investment firm AMP Capital has urged investors to be careful when investing in products created through “financial engineering” or which are hard to understand, noting similar products played a key role in the GFC.

“The GFC was the worst global financial crisis since the Great Depression,” he said.

Advertisement

Advertisement

“It saw the freezing up of lending between banks, multiple financial institutions needing to be rescued, 50 per cent plus share market falls and the worst post-war global economic contraction.”

This was spurred on by a “massive easing” of lending standards, allowing people to receive loans they were unable to service and packaging these loans with other loans to create securities to be sold to investors, Mr Oliver explained.

These products were then given good ratings as a low-risk investment “on the basis that while a small proportion of loans may default, the risk will be offset by the broad exposure”, and then sold to willing buyers under “fancy names”.

Not only did these products play a role in bringing about the subsequent crisis (which occurred after the US central bank drastically increased rates, leaving many people unable to pay their mortgages), but investors who held these particular products were also the most badly affected.

“The biggest losses for investors in the GFC were generally in products that relied heavily on financial engineering purporting to turn junk into [well-rated] investments that were impossible to understand,” he said.

Mr Oliver acknowledged that any potential future market crisis is unlikely to take the same shape as the GFC did, but warned there will be similarities.

“Of course there will be another boom and bust… but as Mark Twain is thought to have said ‘history doesn’t repeat, but it rhymes’ so the specifics will be different next time,” he said.